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The making of tax legislation, like the making of sausage, is never pretty to watch. But the 10-year, $1.35 trillion tax cut that President Bush is expected to sign into law with great fanfare in early June takes ugly to new lows. It isn't so much what the bill does, but the way it does it that makes the new law perhaps the most disappointing piece of tax legislation I've ever seen (and I've been covering tax bills since the 1970s).
Liberals hate the bill because it drains so much money from federal coffers. Conservatives are troubled because it provides only a modest long-term boost to savings and investment. But what may be most troubling are its gimmickry and false promises.
Part of the problem is Congress started out with a specific, if completely arbitrary, number in mind for tax cuts -- $1.35 trillion -- and then did everything in its power to reach it. That's no way to conduct tax policy. Another problem: The conference of House and Senate negotiators on the final version rushed through the process. Normally, conference committees fix the anomolies in tax bills. Not this time.
Result: Not since the invention of the federal income tax in 1913 has there been a tax bill that promised to do so much with so little. Sure, $1.35 trillion sounds like a bucketful. But to make all these promised cuts fit into that trillion-dollar-plus box, Congress created a shooting gallery of tax breaks that appear and disappear, just like those hokey pop-up ducks in an arcade. One year a tax provision is in effect. The next year, good-bye.
POOF, IT'S GONE. Here are just a few examples. Families get new education tax breaks right away but begin to lose them in 2006. Marriage-penalty relief doesn't even begin to help most couples until 2005. Significant rate cuts don't really kick in for wealthy taxpayers until 2007. The estate tax isn't repealed until 2010. And the whole law expires Dec. 31, 2010. That's right -- it expires. Everything would go back to where it is today. The result: A tax bill that looks like Harry Houdini designed it.
To understand what's going on here, let's assume the tax cut really takes place just as the law was written. Taxpayers will get about $45 billion in economic stimulus in 2001 -- mostly through the rebate checks we're all supposed to get by September.
Then the bill provides an additional $350 billion in tax cuts through Bush's term in office, which ends in early 2005. Much of the benefit in these early years goes to moderate-income taxpayers -- those with annual taxable income between $20,000 and $50,000. The big reason: the creation of a new 10% tax bracket.
From 2006 to 2010, the new law is supposed to pump out most of its promised tax relief -- more than $800 billion. Much of that will go to upper-bracket taxpayers, thanks to rate cuts for the wealthy, generous new rules for contributing to IRAs and 401(k) retirement plans, and the repeal of the estate tax.
Then, come 2011, the charade comes to an abrupt end. Tax rates go back up, the estate tax reappears, and the marriage penalty resumes. Why? Because if those tax breaks continued into 2011, it would have cost an additional $250 billion, and Congress didn't want to give Bush the $1.6 trillion tax cut he campaigned on.
NO SUPPLY-SIDE IMPACT. Unfortunately, the problems with this bill don't end with the financial sleight of hand. Think about what this structure means for the economy. Larry Lindsey, the White House's top economic adviser, likes to promote this bill as the tax cut for all seasons. It is, he claims, both a short-term stimulus that can jump-start today's sluggish economy and an engine of long-term growth.
Let's get real. Roughly $45 billion isn't much in a $10 trillion economy. And all those phase-outs negate any supply-side impact, which assumes a compounding effect from long-term savings and investment. In reality, the law is a fiscal version of one of those 1950s do-it-all appliances. Like a combination electric can opener and toothbrush, it purports to do two jobs -- but not very well.
Look at how the tax cuts for upper-bracket folks are handled. On one hand, the new law promises even more generous cuts for the rich than advertised. On the other, it takes them all away. Here's how it works: By 2006, the existing top 39.6% tax bracket is cut to 35%, the 36% rate to 33%, the 31% rate to 28%, and the 28% rate to 25%.
It also eliminates two hidden tax rates -- back-door reductions in the value of both personal exemptions and itemized deductions -- that now clobber taxpayers with more than $136,000 in taxable income. Together, these two adjustments can quietly raise tax rates by as much as three percentage points.
HIT WITH THE AMT. Doing away with these looks good so far. But there's a catch. Under current law, taxpayers in the 28% bracket and above are liable for what is called the alternative minimum tax (AMT) -- a separate set of rules that apply to folks whose deductions and credits lower their tax bill too sharply. Because the new tax bill cuts rates and creates more write-offs, as many as 35 million more taxpayers could be hit with the AMT by the end of this decade.
The bill provides modest relief from the AMT -- but only up until 2005. Then, just as the deepest tax cuts kick in and, paradoxically, taxpayers need help the most, the AMT protections disappear. As a result, if the law isn't changed, about one-quarter of the people who have been promised big tax cuts under the new law are in for a big shock.
Then there's the estate tax. The bill ever so slowly raises the size of an estate exempt from tax from $700,000 today to $3.5 million by 2009. It also gradually lowers the tax rates on estates subject to the levy. Then, on Jan. 1, 2010, the estate tax is repealed entirely.
But Uncle Charlie better die quick. As of December 31, 2010, the estate tax is unrepealed. Even worse, for just that one year, heirs will be required to do a set of immensely complicated capital-gains calculations on the assets for such estates. They won't have to do them for the estates of those who die in 2009, or in 2011. But they will for those who die in 2010.
THE REAL PRICE. No way, you might be saying. Guess again. Maybe somewhere along the line Congress will fix this mess. Perhaps the estate tax and the rate cuts won't really be repealed in 2010. Maybe the AMT problem will be addressed. But if so, then the price tag on the $1.35 trillion tax cut should really be $2 trillion through 2011. And, according to some estimates, it would cost more than twice that -- or a mind-blowing $4.3 trillion -- in the 10 years after that.
It's pretty simple really. Either the new tax law will never really deliver the tax cuts it promises, or it will cost far more than the $1.35 trillion it purports to. Someday this will provide fodder for a textbook case of how not to write a tax bill. In the meantime, Congress is promising the American people something that can't be really counted on.
Gleckman is a a senior correspondent in BusinessWeek's Washington bureau Edited by Beth Belton
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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